Balancing the positive with the negative for the coming year

THIS year has not been a great year for equity investors.

THIS year has not been a great year for equity investors. The spectre of Lehman’s still wields an unhealthy influence, with the merest hints at darker outcomes for both the EU and the wider global economy rapidly translated into equity valuations.

However, not all regions suffered the same medicine. Much in the same way as a balanced portfolio of different asset classes has protected clients from the worst excesses of the various markets this year, so a broad allocation to a range of equity indices would have mitigated some of the losses experienced from European exposure.

It’s obviously hazardous and foolhardy to try and predict what will happen next year. However, our equity positioning for 2012 in country, sector and style terms is based on two main assumptions.

First, the eurozone is not going to break up and the banking sector is not going to collapse.

The ECB has shown willingness to support the latter and we still feel that with markets continuing to force the pace and with little in the way of viable alternatives, we will continue to get stuttering progress on the former.

However, weak or marginalised governments, too many elections coming too soon, rising euro-scepticism alongside a likely European recession, are all likely to combine to keep volatility elevated.

Second, the world is probably not going to follow Europe into recession.

However, there’s likely to be further deleveraging in the developed world and this may mean a slower pace of global growth than we’ve seen in 2011.

All the same, while the developed world digests austerity, we expect the emerging world to continue to ease policy as central banks turn from fighting inflation to supporting growth.

This will keep the world growing at two speeds, with Asia still our preferred emerging market. Set alongside these assumptions, we also believe real yields are likely to remain low in deference to the uncertain macro backdrop.

So, with all this in mind, there are three main themes we advocate to clients entering into 2012:

High yield equities: Low real yields on offer elsewhere, alongside the fact that companies with high payout ratios tend to be the same companies with more stable and defensible cashflows should continue to steer investors towards this theme.

Global quality: By this we mean global blue chip names with geographically diversified revenues and brand names that allow inflation to be passed on down the line. As mentioned above, deleveraging is upon us and in the past this has meant that cash rich and stable large caps trade at a consistent premium, as tighter funding compresses valuations for smaller, riskier stocks that need capital in order to survive.

Asian exposure: The benefits of direct over indirect investment have improved significantly in the last couple of months, with Chinese equities in particular markedly underperforming their developed market peers.

Chinese policy makers have already signalled their intention to switch focus from fighting inflation to supporting growth. We still expect over 8% GDP growth for next year, with consumer focused sectors benefiting in particular as the authorities look to continue to stimulate consumption to balance the economy.

Andrew Miller is regional office head at Barclays Wealth in Newcastle.